Personal Finance (4)

Personal finance refers to the financial decisions which an individual or a family unit is required to make to obtain, budget, save, and spend monetary resources over time, taking into account various financial risks and future life events.

Hong Kong's central bank extended its investigation of possible misconduct in setting the city's benchmark interest rates to HSBC Holdings Plc (HSBA) and other lenders after crackdowns by the U.S., U.K., Japan and Singapore.

The Hong Kong Monetary Authority's probe, which started with UBS AG (UBSN) in December and has since been widened to "a number" of banks, is continuing, the central bank said in an e-mailed statement yesterday. HKMA said it asked London-based HSBC, whose shares are listed in Hong Kong, to "promptly implement" remedial measures required by Singapore's central bank last week following a similar probe in the city-state.

The review of banks setting the Hong Kong Interbank Offered Rate (HIHD03M) and other benchmarks comes amid increased global scrutiny of data submitted for key rates. Singapore last week censured 20 banks for trying to rig its rates and ordered them to set aside as much as S$12 billion ($9.5 billion) pending improvements in their controls. The U.K.'s regulator began looking into the currency market after Bloomberg News reported that traders had manipulated rates.

"HSBC is the largest bank in Hong Kong and the largest participant in the interbank activity, that's why HKMA names HSBC, but that doesn't mean it has a lot of problems," said Steven Chan, a Hong Kong-based analyst at Citic Securities International Co. "HKMA perceives themselves as the most prudent supervisor in the world, so they have to do something."

'Millions of Messages'

The HKMA's investigation has included "millions of communication messages records" so far, according to the statement, which signaled that the probe may take a year because of the number of documents being reviewed. The regulator said in December it will also consider whether any potential misconduct may have had a material impact on the rate.

About HK$1.9 billion ($245 million) of new mortgage loans approved in April were pegged to Hibor, as the Hong Kong interbank offered rate is known, or 11.8 percent of the total, according to data posted on the HKMA website. A year earlier, HK$1.2 billion, or 4.9 percent of new home loans, were tied to Hibor, the data show.

Adam Harper, a spokesman for HSBC in Hong Kong, declined to comment on the HKMA statement. Europe's largest bank, which was founded in Hong Kong and Shanghai in 1865, was required by British regulators to move its headquarters to London from Hong Kong in 1992 following its Midland Bank Plc purchase as part of a push westward.

Shares of HSBC rose 2.1 percent in London trading yesterday. The stock fell 0.7 percent to HK$83.50 in Hong Kong as of 11:01 a.m. local time, paring its gains over the past year to 25 percent.

UBS Probe

The regulator said it began its probe into Zurich-based UBS after overseas regulators alerted the HKMA about potential rate manipulation. Preliminary information provided by one foreign regulator indicated that employees were responsible for the potential misconduct, rather than the bank's systems, HKMA Deputy Chief Executive Arthur Yuen said in December.

Hibor is based on an average of 14 quotes submitted by 20 banks including BOC Hong Kong Holdings Ltd. (2388), HSBC and Standard Chartered Plc, according to the Hong Kong Association of Banks' website. The three highest and three lowest submissions are excluded from the average.

In February, Hong Kong's central bank moved administration of interbank lending rates in the city to the Treasury Markets Association from the banks' lobbying group. Other measures included a decision to review the list of reference banks that submit Hibor rates every year, instead of every two years.

The Hong Kong Association of Banks decided to end the publication of Hibor for tenors that have less demand, such as four- and five-month periods, it said in a June 7 statement.

HSBC said in March it's "unable to reliably measure" costs related to probes of the London interbank offered rate.

Singapore's monetary authority on June 14 said a yearlong review revealed that 133 traders at 20 banks led by ING Groep NV, Royal Bank of Scotland Group Plc (RBS) and UBS, tried to manipulate the Singapore interbank offered rate, swap offered rates and currency benchmarks from 2007 to 2011. The regulator will make rigging key rates a criminal offense and bring supervision under its oversight.

Libor Fines

Barclays Plc, UBS and RBS have been fined about $2.5 billion in the past year for distorting the London interbank offered rate, which is tied to $300 trillion worth of securities. Regulators are also probing ISDAfix, a measure used in the $370 trillion interest-rate swaps market, as well as how some oil product prices are set.

The International Organization of Securities Commissions, or Iosco, a Madrid-based group that harmonizes market rules, identified a set of benchmarks in a January report that could impair the global economy if they were found to be prone to manipulation.

Bank of Communications Co., which is one of the lenders on the rate-setting panel in Hong Kong, said in an e-mailed statement that it hasn't received any inquiry from the city's regulator on the matter. Doris Fan, a Hong Kong-based spokeswoman at Standard Chartered, declined to immediately comment. Spokesmen for Citigroup Inc. in New York and Credit Agricole SA and Societe Generale SA in Paris also declined.

Concern that American stock markets have become more susceptible to split-second crashes due to computerization isn't supported by the data, a Securities and Exchange Commission official said.

Most "mini-flash crashes," a term sometimes applied when an individual U.S. stock briefly surges or plunges for no obvious reason, are the result of human errors, not broken software, said Gregg Berman, head of the SEC's Office of Analytics and Research.

Scrutiny of market disruptions increased in the wake of malfunctions including the flash crash of May 2010, when the Dow Jones Industrial Average fell almost 1,000 points in minutes before rebounding. In September, the Senate Subcommittee on Securities, Insurance and Investment held hearings on the impact of computerized trading amid concern algorithmic and high-frequency strategies are contributing to investor uncertainty.

"A popular meme has emerged that, taken collectively, sudden price spikes indicate a broken market" and may be harbingers of another crash like the one in 2010, Berman said in New York today at a conference sponsored by the Securities Industry and Financial Markets Association. Critics who blame everything on electronic trading "may be looking in the wrong place," he said.

Princeton Physicist

SEC staff found that swings in individual stocks are more often caused by human mistakes such as "fat finger" trades -- when a person enters the wrong number of shares to trade or some other typographical error -- or incorrectly entered limit orders, Berman said. While the errors reflect sloppiness and highlight a lack of checks, they can be fixed by better risk management and oversight, he said.

Berman, who trained as a physicist at Princeton University, was appointed to his SEC post in January. He joined the agency in 2009 from RiskMetrics Group and led the development of Midas, the SEC's system for examining the U.S. stock market.

Sudden stock swings have spurred fluctuations in the paper value of some of America's biggest companies. On May 17, shares of Anadarko Petroleum Corp. (APC), which had a market value of $45 billion at the time, briefly plunged 99 percent in the final minute of trading. Most of the transactions were later voided.

A week later, NYSE Euronext (NYX) let stand trades that sent American Electric Power Co. (AEP) and NextEra Energy Inc. (NEE) down at least 54 percent, while labeling them "aberrant" and excluding them from records showing the stocks' lows of the day.

Bigger Moves

While crashes may be started by humans, today's market structure means mistakes are more likely to snowball rapidly, said Sal Arnuk, a partner at Themis Trading LLC and a frequent critic of the way markets have evolved.

"I would ask Mr. Berman, how can you explain or justify that a large-cap or very liquid stock, when there is a fat-finger trade, sees the market widen out as much as it does," Arnuk said in a telephone interview. The current structure of markets "is set up to extract the most amount of pain from any mistake."

A study published by Credit Suisse Group AG on Jan. 17 found that few sudden swings are directly attributable to computer errors.

Ana Avramovic, an analyst at Credit Suisse Trading Strategy, examined mandatory halts prompted by volatility in individual stocks between June 2010 through December 2012. After excluding "extremely illiquid or cheap stocks," she found that 85 percent were caused by news and 9 percent by human error.

Latency Arbitrage

Only 6 percent -- or 21 instances in 31 months -- were caused by a bad print, when a quote at an extreme price caused a halt, suggesting a computer algorithm was responsible.

Recent research from the University of Michigan explored another point of contention regarding high-frequency trading: whether investors generally benefit from the practice.

The report found that while a technique known as latency arbitrage -- in which traders exploit delays in sending market data among the 13 exchanges and about 40 alternative venues in the U.S. -- enriches some firms, overall market efficiency is harmed "with no countervailing benefit in liquidity or any other measured market performance characteristic."

Berman said today that while the SEC continues to study computer trading, other measures should limit human mistakes. He highlighted the proposed Regulation Systems Compliance and Integrity, which seeks to limit technology breakdowns at venues handling stocks, options and bond trades and ensure they can withstand malfunctions that could jeopardize markets.

Risk Checks

Another initiative, the market-access rule adopted in 2010, requires risk checks on any order sent for execution. The two together are a message to market participants and venues to improve, Berman said.

In remarks to the Sifma audience, Berman also questioned critics who suggest computers have made buying and selling stocks too fast for the good of the market. He said the SEC's analysis will look at the speed of trades, and he will reserve judgment until it's complete.

"I'm not sure why, absent other facts, it should be a concern that trading take place faster than a blink of an eye," he said.

Twice a year, Jim Bruene puts three dozen of the country's most innovative entrepreneurs on a stage and starts a stopwatch. In seven minutes, they must show how their latest idea could transform the financial industry.

The presenters at Finovate, the conference Bruene first organized in 2007, try to wow bankers, venture capitalists and tech executives with cool graphics and idiot-proof interfaces. The typical demo strives to prove that banking, investing and managing money can be easy as swiping a finger across a screen.

The star of the first Finovate was personal finance management site Mint.com; two years later, Intuit bought Mint.com for $170 million. More recently, Lending Club, which has presented three times at Finovate, got a $125 million investment from Google that valued the peer lending site at $1.6 billion.

A former banking executive, Bruene started the "Online Banking Report" in 1994. He still publishes the industry newsletter, though Finovate is now far more lucrative. Last month's San Francisco Finovate attracted almost 1,300 people, and tickets to its next gathering in New York on Sept. 10 and 11 sell for $1,295 and up. The company added yearly events in London in 2010 and Singapore in 2012.

Bruene, 54, spoke to Bloomberg.com's Ben Steverman about how technology is changing the way we spend, save and invest -- and whether we're likely to use our phones as "digital wallets" any time soon. Edited excerpts of their conversation follow.

Are you an early adopter of innovative financial products in your personal life?

I am pretty hands-on when it comes to "fintech" and try to use as much as I can. I've been using [mobile payments app] Square Wallet at a few coffee shops in Seattle, along with the Starbucks mobile app. I have accounts at online bank Simple and at peer-to-peer lenders Lending Club and Prosper.

What are the latest trends in financial technology that you're seeing?

The most interesting thing now is "crowdfunding." Person-to-person lending like Lending Club and Prosper fall into the same category. It's always been tricky for banks to make smaller business loans. In the last five years especially there was an ice age for a while. Right now investors are putting money in these things because, if you can loan some money out to a business or an individual for a 6 percent interest rate, you're fairly happy as an investor. You can fund all kinds of different assets.

There's a company called Mosaic that does solar installations. You're putting your thousand dollars into a solar installation in Phoenix that's going to give you a 7 percent return over three years on your money.

What about concerns about loan quality on these online lending sites?

Loan quality will always be an issue. Some of the initial lenders lost quite a bit of money in Prosper in 2006 to 2008, sometimes losing 10 to 20 percent of principal. In the last three years, Prosper and Lending Club have tightened underwriting standards and have kept loss rates at a reasonable level. Consumers investing through these sites don't have absolute security like FDIC savings accounts, but they are being compensated for the extra risk.

Overall, the risk-adjusted returns seem reasonable now. Other crowd lenders targeting small businesses and other assets may have wildly fluctuating returns and are only accepting accredited investors at this point.

How is the widespread adoption of mobile phones affecting the financial industry?

Mobile technology is one of the reasons we started Finovate. Technology is changing how people bank -- from at a branch or over a voice phone call to online and mobile.

Right now, authentication and biometrics through mobile phones is the hot area. As we just saw at a Finovate conference in San Francisco, the way you type on the phone, the way you walk with the phone -- these are all indicators that the phone is in its owner's hands. From a consumer standpoint, authentication technologies can take away a little pain point -- the need to log in to check your balance or take a payment.

I'd imagine for the banks it could take away a huge pain point, which is credit card fraud.

Yes! Fraud and fraud resolution -- all those phone calls you get from your credit card company saying, "Did you make this transaction?" That stuff is expensive and aggravating.

There are many different ideas for how to use a mobile phone as a "digital wallet," as a payment method. There are competing technologies, and commentators have pointed out that it's not really that hard to use a credit card. Is this a solution in search of a problem?

There's no doubt that the physical wallet goes away eventually. A plastic card is a little token to this vast computer payment system. So why would we have it if it worked better on the phone? If it knew who you were and it was all secured. Eventually this all ends up in some kind of a cloud.

When's the "eventually"? Fifty years from now, or 20 years from now? I don't think it's five years from now. It's fairly out there, because the infrastructure of how to pay has to change. That's the kicker. If every place that you walked with your phone took it as a payment device, then you'd use it. That's not the case. There's this problem of retrofitting payment terminals.

In the meantime, you can make the credit card work better, preventing fraud by using the phone to prove it's you using the card.

One aspect of the mobile "digital wallet" that's discussed a lot is personal financial management, or PFM. The focus there isn't so much on the transaction itself as on everything that happens before and after, such as mobile apps that can help consumers make better spending and investing decisions. What do you think of PFM?

My advice to banks is to provide all those things and call it a "mobile wallet." Let all your transactions flow into your phone instantly. Some people say you can't do all this stuff in the phone -- it's too limiting and you need the keyboard and the real estate of the personal computer. No, it's better in the phone, because it's instantaneous. You can get it whenever and whereever you want to.

I love what the bank Simple calls their Safe to Spend meter. This little meter runs on your phone or desktop. It keeps track of your bills and your paycheck and it says: Stop spending, because you don't have anything left after your mortgage that's due in six days.

To what extent do you expect technologies to really disrupt the financial industry, and to what extent will financial institutions step up and do the innovations themselves?

Certainly in the stock trading world and in investment advice there's been a lot of new players, like TD Ameritrade.

On the banking side, the traditional players have the same market share of deposits as they did 18 years ago, when the Internet got popular. Consumers are risk-averse with their money -- they don't glom onto the latest thing they heard about on Twitter. Also, it's a hassle to change accounts, and in banking the existing players have stepped up and done what consumers want.

On the lending side, there's more chance of disruption, especially with crowdfunding. As a consumer, how do you shop for a line of credit or even a mortgage? It's hard. It's not transparent. You don't know if you have a good deal until you apply for it. That's an area where new players can make inroads. Plus, borrowers will take money from anyone. That's proven in the credit card world. When people get that pre-approved mailer, they don't care whose name is on the envelope.

As the S&P 500 stormed to a gain of 16 percent for the first five months of the year, the run was fueled by investors searching for yield.

With central banks driving interest rates lower, slower-growth sectors with big dividends like utilities and telecom were attractive because they offered better returns over government debt along with the possibility of price appreciation.

Those sectors led stocks higher for several months - but that outperformance appears to have come to an end as U.S. Treasury bond yields climbed to 13-month highs this week. The economic outlook in the United States has improved, and rumblings of a pullback in the Federal Reserve's massive bond-buying program have caused investors to pull away from the big dividend payers.

For the year through April 30, the S&P 500 rose 12 percent, led by an 18.4 percent gain in both utilities and healthcare, as well as a 17.1 percent climb in consumer staples.

The S&P 500 - with only one trading day left in May - has climbed about 4 percent this month - giving the benchmark index a gain of 16 percent for the year so far, based on Thursday's close.

Central banks have kept yields low through heavy bond purchases, prompting investors to bid up the prices of corporate and high-yield debt, along with stocks. Still, insecurity about global recovery meant investors looked for "safer" versions of risky assets.

With the S&P 500 showing a dividend yield at 2.4 percent, investors were drawn to sectors with higher yields. The dividend yield on telecoms stands at 4.6 percent, while the utilities sector is at 4 percent and the consumer staples sector is at 2.7 percent.

The S&P 500 just kept going in May, rising 3.6 percent so far. But utilities have been crushed, falling 9.2 percent, while staples have dipped 0.2 percent and telecoms have stumbled 5.2 percent.

"Because a lot of portfolio managers have been hanging out in the defensive groups - the utilities and the consumer staples - because they were scared of the overall market, they had bid those two sectors, from a historic perspective, to pretty expensive valuations," said Jeffrey Saut, chief investment strategist at Raymond James Financial in St. Petersburg, Florida.

LOFTY VALUATIONS

A look at the more defensive sectors that hold a large portion of dividend payers shows they have, in fact, become expensive relative to their non-dividend paying peers.

According to Thomson Reuters data, the S&P telecom sector index - composed of stocks such as AT&T Inc and Verizon Communications - sports a forward price-to-earnings ratio for the next 12 months of 18.29, and the forward P/E ratio for the S&P utilities sector index stands at 15.84.

The forward P/E ratio is a valuation measurement comparing a stock's price to expectations for its earnings for the next 12 months.

Since the beginning of 2000, the telecoms sector has averaged a forward P/E ratio of 16.70, while the utilities sector has averaged a P/E ratio of 13.46.

By comparison, the forward P/E ratio for economically sensitive sectors such as industrials stands at 14.59, while technology is at 13.11 - both below long-term norms.

For the S&P 500 as a whole, the forward P/E ratio is 14.36.

"Investors have realized they have bid these defensive stocks up pretty fully. They are now starting to look ahead to the second half of this year, where we think economic growth is going to be better, and they are looking at a lot of the economically sensitive stocks that are much cheaper than the defensive stocks," said Phil Orlando, chief equity market strategist at Federated Investors in New York.

Investor interest in dividend funds has remained steady in 2013 even if it's not as robust as in 2012. However, more investors have started to return to growth-and-value strategies, according to Lipper, a unit of Thomson Reuters. In 2012, dividend funds drew inflows of $14.74 billion, compared with outflows of $23.39 billion from growth-and-value funds, Lipper data showed.

Through May 22, dividend funds recorded inflows of $7.28 billion, compared with inflows of $13.31 billion in growth-and- value funds.

Dividend-oriented exchange-traded funds have dropped off in recent days, with the iShares High Dividend Equity Fund falling 1.9 percent in the last 10 days.

The rise in U.S. Treasury bond yields to 13-month highs on Wednesday has also taken some of the shine off the dividend payers as investors start to expect that the Fed could soon scale back its stimulus measures. Higher yields on risk-free government debt make stocks less attractive to more conservative investors.

If the economy does improve in the second half of the year and speculation increases that the Fed may begin to - or actually does - taper its bond-buying plan, the rotation away from dividend payers may accelerate.

Oddly, stocks overall may end up stronger in the longer run.

"If the rotation to cyclical stocks presages more improvement in the economy, the rotation should stick," said Brad Lipsig, senior portfolio manager at UBS Financial Services Inc in New York. "If the economy softens, you would expect the reverse," he added.

"But the slow arduous rotation back to stocks from 'anything but stocks' should continue for decades."